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Chicago raised eyebrows when the city announced a streaming tax on Netflix and similar internet services, the first of its kind in the country. The so-called “cloud tax” was a 9% surcharge for the privilege of streaming internet-based entertainment, including video, music and gaming services. In response, the Liberty Justice Center filed a lawsuit challenging the tax on behalf of Chicago taxpayers. This week a court ruled in favor of the city, upholding the tax.

Chicago has argued that the “cloud tax” isn’t a new tax, merely an interpretation of the city’s amusement tax which imposes a tax “upon the patrons of every amusement within the city.” Before 2015, the tax did not include language that expanded the definition of amusement to include “any paid television programming, whether transmitted by wire, cable, fiber optics, laser, microwave, radio, satellite or similar means.” That language was adopted by rule effective July 1, 2015 (downloads as a pdf).

Under the ruling, individuals “whose residential street address or primary business street address is in Chicago, as reflected by their credit card billing address, zip code or other reliable information” are subject to the amusement tax. While it’s ostensibly a tax on end-users, the responsibility of collecting and remitting the tax belongs to the providers of internet services.

The plaintiffs first challenged the tax by filing a complaint on December 17, 2015. The city of Chicago, as Defendant, moved to dismiss the complaint, and the court granted the motion, but only in part. Plaintiffs subsequently filed a Second Amended Complaint, and the matter has proceeded through the court system since that time.

Most recently, more motions were filed. This time, the plaintiff's motion for summary judgment was denied, and the defendants’ motion for summary judgment was granted. Summary judgment is a legal term that means that a judge has determined that all of the factual issues have been decided, and a decision can be issued without a complete trial. The mechanics can be complicated (because, lawyers), but typically, summary judgment is granted when the facts are considered so overwhelmingly in favor of one party that there is no need to proceed further.

As part of a summary judgment order, the court typically states on the record the reasons for granting or denying the motion.

In this case, the plaintiffs had argued that the cloud tax was:

a violation of the federal Internet Tax Freedom Act (ITFA);

a violation of the United States Commerce Clause;

a violation of the uniformity clause of the Illinois Constitution; and

an extraterritorial application of Defendants’ taxing power.

The plaintiffs first argued that the amusement tax is unfairly applied and imposes a discriminatory tax on users of streaming services, as compared with lower taxes on live performances. However, the court found that the plaintiffs could not equate live performances to movies and music streamed online “because they are different amusements.” Declaring that “watching a performance on a television monitor is not in any way similar to watching a live performance,” the court wrote that the disparity did not create a violation of the ITFA.

The court shot down a similar argument involving automatic amusement machines (those operated with a coin, slug, token, card or similar object), which are subject to an annual tax. Noting that automatic amusement machines are stationary devices owned by businesses, the court found “real and substantial differences” between the amusements, including the fact that the streaming customer is generally the exclusive user of the product, which is paid for on a subscription basis, as opposed to automatic amusement machines, which are shared among all customers and operated on a per use basis. This, the court found, was a “sufficient justification for the difference between the treatments in taxes.”

The court also ruled that the amusement tax is applied to an activity (streaming) with a substantial nexus with the City, is fairly apportioned, does not discriminate against interstate commerce and is fairly related to services that the City of Chicago provides to the taxpayers. With that, the court dismissed the case.

According to Jeffrey Schwab, senior attorney at the Liberty Justice Center, there will be an appeal. “We plan to appeal this decision, because it has far broader implications than this single attempt to tax online entertainment. Cloud-based entertainment isn’t unique to Chicago, and people take this entertainment in and out of city limits all the time. Therein lies one of the biggest problems with this tax: The city is taxing activity outside its borders because the tax applies regardless of whether a customer actually uses a service in Chicago. If today’s decision is allowed to stand, then local governments across Illinois could tax activity that occurs outside their borders. We will continue to fight for taxpayers against the city’s expansion of its taxing power.”

The case is Michael Labell, et al, v. The City of Chicago et al, No. 15 CH 13399, (Cir. Ct. Cook County). You can read the ruling here (downloads as a pdf).

Years ago, I found myself sitting in law school in Moot Court wearing an oversized itchy blue suit. It was a horrible experience. In a desperate attempt to avoid anything

…

Years ago, I found myself sitting in law school in Moot Court wearing an oversized itchy blue suit. It was a horrible experience. In a desperate attempt to avoid anything like that in the future, I enrolled in a tax course. I loved it. I signed up for another. Before I knew it, in addition to my JD, I earned an LL.M Taxation.
While at law school, I interned at the estates attorney division of the IRS. At IRS, I participated in the review and audit of federal estate tax returns. At one such audit, opposing counsel read my report, looked at his file and said, "Gentlemen, she’s exactly right." I nearly fainted. It was a short jump from there to practicing, teaching, writing and breathing tax. Just like that, Taxgirl® was born.